Study on hedging strategies of Indian organizations

Organization - Axis Bank
Fa u l G u i e : ty d Pro f V ri a l B h a t . sh i I d u stry G u i e : n d M r. S a n d e sh C R By – Anupam Chaplot

Various entities involved in Banks Forex operations

SWOT Analysis

Objective
To learn about the major

FOREX related products provided by Banks. Try to find out hedging strategies for the customers by analyzing data from recent past. To study the forex strategy of market leaders in various sector and find out the instrument they use for forex risk management.

Hedging Strategies/Instruments
Forwards Options Futures Swap Foreign debts

Forwards
Advantage: can be tailored to the specific

needs of the firm and an exact hedge can be obtained. Disadvantage: On the downside, these contracts are not marketable, they can’t be sold to another party when they are no longer required and are binding.

Options
Advantage: limited downside risk and the

flexibility and variety of strategies possible. Disadvantage: More expensive. The price is therefore a disadvantage.

Swaps
Advantage: The advantages of swaps are that

firms with limited appetite for exchange rate risk may move to a partially or completely hedged position through the mechanism of foreign currency swaps, while leaving the underlying borrowing intact. Apart from covering the exchange rate risk, swaps also allow firms to hedge the floating interest rate risk. Disadvantage: Not too useful for short term.

Future
Advantage: There is a central market for futures. Disadvantage: only standard denominations of money

can be bought instead of the exact amounts that are bought in forward contracts.

 

Standardized currency futures shall have the following features: a. Only USD-INR contracts are allowed to be traded. b. The size of each contract shall be USD 1000. c. The contracts shall be quoted and settled in Indian Rupees. d. The maturity of the contracts shall not exceed 12 months. e. The settlement price shall be the Reserve Bank’s Reference Rate on the last trading day.

Foreign Debt
 

Foreign debt can be used to hedge foreign exchange exposure. example: An exporter who has to receive a fixed amount of dollars in a few months from present.

Methodology
For

the purpose of analyzing which hedging instrument will suit the need of Indian organizations better data of last 4 years of rupee/dollar currency movement has been used. The hedging instrument used by various organizations have been

Firms studied
IT: Infosys, Wipro, TCS Pharmaceutical: Ranbaxy, Dr. Reddy’s Automobiles: Tata Motors, TVS, Bajaj Auto Telecom service provider: Idea, Airtel Steel Manufacturer: Tata steel, JSPL

Findings/ Results
1 month 2 month 3 month 4 month 5 month 6 month 1 year forward 31 Options 16 35 11 32 13 33 11 32 11 31 11 24 12 2 year 15 9

  FORWARDS ( exporter ) Duratio 1 month 2 month 3 month 4 month 5 month 6 month 1 year 2 year n SD 1.06417 1.772992 2.232811 2.58581 3.027273 3.609369 6.073091 4.054013 average 0.11234 0.203696 0.281333 0.357045 0.412093 0.44881 0.183333 -2.9075

  OPTIONS Duratio 1 month 2 month 3 month 4 month 5 month 6 month 1 year 2 year n SD 0.744974 1.239559 1.469036 1.516969 1.70461 1.998449 2.827656 2.023584 average 0.252979 0.255435 0.164222 0.071591 -0.02674 -0.03024 -0.66 -6.26667

  Unhedged Duratio 1 month 2 month 3 month 4 month 5 month 6 month 1 year 2 year n SD 1.06417 1.772992 2.232811 2.58581 3.027273 3.609369 6.073091 4.054013 average -0.04234 -0.0637 -0.07133 -0.07705 -0.06209 -0.02881 0.656667 4.5875

Infosys Derivative forward contract

foreign currency (in millions) $245 € 20.00 £15.00 $113

INR (crores) 1243 135 109 573

option contract range barrier

TCS Derivative forward contract Option

foreign currency (in millions) $153.50 $907.60 £4.00 € 5.00

INR (crores) 775.71 4586.528464 29.07 33.75

WIPRO Category Forward contracts

Options

Cross-currency interest rate swap

Amount (in millions) $1,374 € 79 £ 53 $438 ¥ 23,170 $562 £ 54 ¥ 6,130 ¥ 35,016

Buy/Sell Sell Sell Sell Buy Buy Sell Sell Sell -

Conclusion
Currency swaps are more cost-effective for

hedging foreign debt risk, while forward contracts are more cost-effective for hedging foreign operations risk. Forwards contracts can be tailored to the exact needs of the firm and this could be the reason for their popularity.

Conclusion(contd.)
Swap usage is a long term strategy for hedging

and suggests that the planning horizons for these companies are longer than those of other firms. Most Indian IT companies have increases use of Options instead of Forwards owing to high market volatility.

Conclusion ( contd.)
Software firms have a limited domestic market

and rely on exports for the major part of their revenues and hence require additional flexibility in hedging when the volatility is high. Another implication of this is that their planning horizons are shorter compared to capital intensive firms. Most Indian firms use forwards and options to hedge their foreign currency exposure. This implies that these firms chose short-term measures to hedge as opposed to foreign debt.

Limitations
Only few firms specific to each sector has been

studied The firms are market leaders in respective sector, the same conclusions might not hold true for small firms. The data about the organizations have been studied for small time period. Currency Movement of just rupee/dollar has been analyzed.

Other Observations
Coordination among the branches

Different rates across branches Documentation ( for internal audit)

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THANK

YOU

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